Political paralysis continues to hamper Kuwait’s economic prospects, though the country’s conservative budget should at least provide a comfortable cushion should oil prices fall.Published in The Gulf, February 2012

On the surface at least, Kuwait’s economy is doing just fine. Last year the country enjoyed its largest ever budget surplus, of KD5.3 billion ($19 billion), despite a sharp increase in government spending. This year, its gross domestic product (GDP) is expected to grow by a healthy four to five per cent and the surplus could be even higher.

This happy situation is almost entirely because of what lies below the surface, with high international oil prices providing the fuel that keeps the economy moving. The price of Kuwait Export Crude averaged $82.50 per barrel in the 2010/11 fiscal year, according to the National Bank of Kuwait (NBK), almost twice the target set in the budget of $43 per barrel.

Although the budget price is higher this year, at $60 per barrel, NBK’s base case prediction for the year is that Kuwaiti crude will sell for an average of $104 per barrel and the government will book a surplus of KD7.5 billion. It seems the country has little to worry about, even if oil prices do start to fall back.

However, the budget surpluses also hint at some more worrying aspects to the local economy. Revenues are only outpacing expenditure by such a huge margin because, unlike in other countries in the Gulf, the Kuwaiti government finds it difficult to spend all the money it receives.

“Kuwait’s budget surplus is by far the biggest in the GCC,” says Liz Martins, a senior economist at HSBC Middle East. “What that says is that while there is lots of oil money coming in, it is getting stuck and not actually being spent and invested in the economy. That’s evident in a lack of infrastructure development and the failure of the non-oil economy to keep pace with some of the more dynamic economies in the region such as Dubai.”

The key reason for this is Kuwait’s unusual political system, in which a cabinet appointed by the Amir, Shaikh Sabah al Ahmad al Jaber al Sabah, regularly clashes with the elected National Assembly (parliament). The only real power that MPs have is the ability to disrupt the legislative process, as they cannot initiate any bills themselves. It is a situation which tends to encourage gridlock and opposition rather than cooperation. In turn, it means that significant economic reforms or investments take a long time to be agreed on, if they happen at all.

There are other problems that the country is grappling with which have also served to undermine its political and economic prospects, not least a corruption scandal involving payments to pro-government MPs. This came to a head in November 2011, when a group of protesters stormed parliament. The government of prime minister Shaikh Nasser Mohammed al Ahmed al Sabah subsequently resigned, just days before he was due to face questioning on the matter by parliament.

In his place the Amir appointed a new prime minister, Shaikh Jaber Mubarak al Hamad al Sabah, who had been defence minister in the previous cabinet. This in itself was a significant departure, as on the six previous occasions that Shaikh Nasser Mohammed had resigned since 2006 the Amir had simply reappointed him. A new parliament will be formed in February, following elections on 2 February, but to date there has been no sign that a change of face at the top of government will prompt a more constructive accord to emerge between the cabinet and parliament.

“The problem in Kuwait is the relationship between parliament and government which is almost set up to be negative rather than positive,” says Kristian Coates Ulrichsen, Kuwait research fellow at the London School of Economics. “There’s a mistrust between the government and parliament which has held back a lot of projects in the past. Giving parliament a more positive say in framing government decisions and making them more involved would be a solution in the medium to longer term.

“They need to find a way forward because at the moment they have the worst of both worlds. They don’t have an autocratic system like, for example, Qatar or Dubai, where they just make an executive decision and move ahead, but they’re not a properly functioning democratic system either.”

The lack of substantial change in the political system means there is little momentum for change in the economy either. The government is now in the middle of a planned $100 billion development programme designed to boost investment in health, education and infrastructure and, in the process, diversify the economy too. However, this is already showing signs of falling victim to the political stasis and many independent observers expect the government to miss its spending targets this year.

Last year’s expenditure target was only reached as a result of a grant to all Kuwaiti citizens of KD1,000 in cash along with higher subsidies on a range of basic food stuffs. The handouts had been prompted by the onset of the Arab Spring and started a trend among Gulf states to effectively try and buy their citizens’ silence.

A privatisation drive is also showing signs of strain. A long-running plan to sell a stake in the national carrier Kuwait Airways was put on ice in October while the company is restructured. That in itself was a recognition of the difficulties the airline was in and the problems there would be in finding a buyer for what is widely seen as a bloated and inefficient operator.

“The spending plans are very impressive and if they happen they’ll be very positive,” says Martins. “Privatisation is on the cards and it would be great if they did that too. But these things have been talked about for a very long time and, historically, the reality has been disappointing. There’s nothing that we’ve seen to suggest that has changed and we don’t see any reason why this year will be any different.”

The problems at Kuwait Airways are emblematic of the country as a whole. The state’s oil wealth has meant there has been little motivation to innovate or improve efficiency, even if the economy is suffering relative to the advances made in other countries to the south.

As Moody’s said in a report on 19 January, which reiterated the country’s bond rating of Aa2, “partly because of its vast oil wealth, Kuwait has been slower than some other GCC states to develop its non-oil sector through encouraging private sector activity and attracting foreign investment. This has resulted in an oversized public sector.”

Despite the difficulty in selling some state assets and the dominance of the oil sector, which accounts for around 50 per cent of GDP, there are a few areas where the private sector has thrived. They include the finance industry, which makes up 10 per cent of total GDP, and the transport and communications sector, which accounts for a further eight per cent. The key companies in these areas include the regional telecoms giant Zain, logistics firm Agility, and banks such as National Bank of Kuwait and the sharia-compliant Kuwait Finance House.

Foreign investment could help to invigorate the economy, but the difficult political environment dissuades many international investors from getting involved. Foreign direct investment in Kuwait has historically been the weakest in the GCC, accounting for less than two per cent of the regional average in eight of the past ten years.

Predictions for the economy in the coming years suggest that little will change. The Economist Intelligence Unit suggests an average GDP growth rate of five per cent from 2012 to 2016, which is in line with its performance over most of the past five years, excluding the downturn in 2009.

The country also has the benefit of huge overseas investments, with the Kuwait Investment Authority being the longest running of any sovereign wealth fund in the GCC. Coupled with its small population it means that even if oil prices did fall sharply, the country has the ability to deal with the pressure that would bring.

In the longer term Kuwait could also play an important role in the reconstruction of Iraq, but relations between the two countries are fractious. They have clashed over plans to build rival ports on the Gulf, with Iraq preparing a major new shipping hub on the al Faw peninsula and Kuwait constructing the Mubarak al Kabeer port nearby. There are also outstanding compensation payments that are due to Kuwait as a result of Iraq’s invasion of the country in August 1990.

In the meantime, the danger is that Kuwait will simply continue to lose ground to its Gulf neighbours as their economies move ahead and it will begin to look like an even less attractive investment destination.

“The problem for Kuwait is that it is in an intensely fast-paced environment,” says Kristian Coates Ulrichsen. “It’s neighbours are pushing ahead with incredible speed so even staying still is not an option. When you have multiple visions in the Gulf to become regional or even global hubs for transport, aviation, logistics and finance services you really are up against it.”